Dollar Hangs Tight on GM Risk, Recession Trades Still On

Signs of stability in the US manufacturing sector has failed to turn around the market’s risk appetite. Although the US dollar has weakened marginally against all of the major currencies, if US stocks continue to sell off, we could see the dollar regain strength.

Will the US government allow GM to fail?

The fate of General Motors will be the biggest event risk until the end of the month. In my opinion, the US government will not allow GM to fail. President elect Barack Obama has already pledged on numerous occasions to support the auto and retooling industry. To back off his promises so early in the game would be a reputation killer and not something the world expects from Obama. House Speaker Nancy Pelosi has also called on Congress to pass an emergency rescue package for the industry. Given that 1 in 10 jobs in America deals with the auto industry (from dealerships, auto parts etc), there is no question that the US government will extend life support to General Motors.

Nonetheless the longer the US government stalls, the more strain it puts on the financial markets, because investors don’t like uncertainty.

G20 Holding Out for Obama

The G20 meeting this weekend was also a big disappointment. With slightly more than 2 months to go before the US Administration changes, this was hardly a surprise because President Bush was not expected to commit his successor Barack Obama to any initiatives that he does not support. Since the group set an action plan for March 31 and another meeting for April 30, the G20 is clearly waiting for directions from Obama’s new Administration before putting the pedal to the mdeal. . The only problem is, the global economy may not be able to wait that long.

Recession Trades Still On
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Global Unwind Continues, Paulson Doesn’t Help

The global unwind continues this morning with US equities, commodities and currencies taking another beating. The US dollar and Japanese Yen continue to outperform with the British pound hitting a fresh 5 year low.

The story is still the same, which is sell first and ask questions later. It is earnings season and the reports that we have seen so far are a harsh reminder of the growing problems in the US economy. Retail sales are due for release on Friday and the warnings from retailers indicates that consumer spending has slowed materially.

Best Buy cut its full year forecast today, DHL is shutting down its US operations and Circuit City became the 14th retail chain to go bankrupt, joining companies like Linen N Things and Steve and Barry.

We are in a global easing cycle and the market expects central banks around the world to follow the UK’s aggressive interest rate cuts.

Central Bank Meetings: What Do I Expect for December

Federal Reserve: 50bp cut
Bank of England: 75bp cut
European Central Bank: 50bp cut
Reserve Bank of Australia: 75bp cut
Reserve Bank of New Zealand: 75 to 100bp cut
Bank of Canada: 50bp cut
Bank of Japan Japan: no rate cut

Paulson’s comments aren’t helping either:
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What Matters More? The Good or the Bad

Every day, equities, currency and bond traders weigh the good news with the bad to determine if they want to buy or sell.

Today, there were just as many positive reports that should have helped to stabilize the markets but has instead failed to stem the bleeding in equities and currencies.

In a market environment where pessimism is being felt in the bones of investors, it has become increasingly difficult to shift market sentiment.

The US dollar and the Japanese Yen continued to outperform as risk aversion drags nearly all of the major currency pairs lower. Even though USD/JPY has remained unchanged, the EUR/USD and GBP/USD fell more than 200 pips.

The Good News: US Government Accelerates Efforts to Minimize Foreclosures

As investors remain nervous about the outlook for the global economy, good news has failed to have a positive impact on risk appetite. Today officials from the Treasury and the Federal Housing Finance Agency said that through Fannie Mae and Freddie Mac they plan on accelerating efforts to help homeowners that are facing foreclosures. This includes reducing interest rate and extending loan terms, which should have been perceived as a step in the right direction. More specifically, the mortgage servicers will help borrowers who are more than 90 days delinquent bring their monthly payments down to 38% of their gross income, which is now considered the threshold of affordability. For an American that earns $75,000 a year, affordable means monthly payments of $2375 or under.

In addition after falling to a record low, IBD/TIPP reported a material improvement in economic optimism.

The Bad News: Fears of GM Bankruptcy

However the market has completely shrugged off the positive developments and has instead chosen to focus on the fears that General Motors will be forced into bankruptcy. The White House has indicated that they are open to accelerating the loans previously approved for the auto industry while House Speaker Nancy Pelosi called on Congress to pass an emergency rescue package for the industry.

$25B loans were originally allocated to the automakers for developing more fuel-efficient vehicles, but the legislation could be changed to divert the money towards more urgent initiatives such as helping the automakers fend off bankruptcy.

Given President-elect Barack Obama’s pledge to help the auto industry last week, official support is inevitable. However if the government does not act fast, the market could push the automaker into bankruptcy. On Monday, analysts issued price targets of zero for GM’s stock. With 263k workers under their umbrella, General Motors could be too big to fail.

EUR: Pressured By Problems in the Banking Sector
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Dollar Closing In on 5% Targets, Where are the Value Points?

The type of moves that we have seen in the currency market during the Asian and European trading sessions are typically what we see in a quarter or a half year. USD/JPY has fallen 5 percent, AUD/USD is down more than 8.5 percent while the NZD/USD is down 7 percent. The sell-off in the Japanese Yen crosses are even more severe with AUD/JPY down 13.5 percent and NZD/JPY down 12 percent. Here is a list of the biggest movers as of 9am ET:

Yesterday, I warned against a premature top in the EUR/USD!

Although it may be very tempting to say that the dollar has hit a top, especially against the Euro, in order for this EUR/USD rally to be real and for investors to be convinced to stop selling higher yielding currencies, we need to see stabilization in the financial markets and a return of confidence.

The mentality in the currency and stock markets is sell now, ask questions later. The low yielding US dollar and Japanese Yen continue to be the biggest beneficiaries of risk aversion. The only thing that investors want right now are safe haven plays. The dollar’s strength will force emerging market countries to rush to prevent a flight of capital out of their currencies – more rate hikes could be likely. With deleveraging being the theme of the day, when confidence is lost, it will be difficult to recover.

Where are the Value Points for the Currency Market?

In the Wed edition of my Daily GFT Report and on CNBC and Bloomberg I talked about how the dollar could rise another 5%. At that time, the EUR/USD was trading at 1.2829 and the GBP/USD at 1.6236. The GBP/USD has already hit my 5 percent target and at one point this morning even became undervalued on a purchasing parity basis. Although the UK GDP report confirms that the country is headed for a recession and validates the weakness, I believe that we have seen a near term low in the currency pair.

The EUR/USD on the other hand has only dropped 2.5 percent. The EUR/USD does not become a value play until 1.15-1.20. As for USD/JPY, it has also reached my target of 95. Although I won’t be a buyer at these levels, I won’t be a seller either. There are no rewards for heros in this type of market.

Will the BoJ Intervene?

If you are wondering about Bank of Japan intervention, don’t expect it to happen. As an export dependent nation, a strong currency is not in Japan’s best interest. However unlike in the past where the BoJ has intervened when USD/JPY fell below 105 and 100, we may not see any action by the Japanese government this time around. Since the problems are inherent in the US and the Eurozone, intervening at this time may be counterproductive for the Japanese. The Japanese government needs to stand aside and allow the US and Eurozone governments to take their measures to spur growth and not strengthen the dollar for their own short term relief.

If intervention was on the table, the Japanese PM would not make the following comment this morning:

RISE IN YEN NOT ALWAYS BAD BECAUSE IT PUSHES DOWN OIL PRICES FOR JAPAN”

Risk of Limit Down Day in US Stocks

With S&P futures already trading at limit down this morning, there is a decent chance that circuit breakers may be hit in the first hour of trading. The moves in the Dow Jones Industrial Average these days is strikingly similar to the move in 1906 and 1907 (Here is a chart from Barclays). In the last phase of the sell off between Q2 of 1907 and Q4 of 1908, the Dow dropped 37% before it bottomed out. From the August 11500 levels in the Dow, a 37% move would take the index down to a new 6 year low of 7245.

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Barclays Capital

Barclays Capital

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Bailout Plan Fails to Impress, Traders Worried More About Dominoes Effect

The Congressional agreement of the $700 Billion bailout plan has proved to be anti-climatic for the stock and currency markets. There was a relief rally in the US dollar Sunday evening, but it lasted for no more than a blink of an eye as more problems came knocking on the door for financial institutions. Investors quickly moved onto the latest problems with a string of bank bailouts announced in Europe and the practical failure of Wachovia. Being sold at $1 a share is almost the same as filing for bankruptcy.

THE DOMINOES EFFECT

The US dollar has weakened against the Japanese Yen, but its strength against the Euro and British pound indicate that the concerns for those currency pairs now shift to the prospect of further bank failures in Europe. In the Eurozone, Fortis was bailed out by Belgium, the Netherlands and the Luxembourg governments while the Hypo Real Estate group was bailed out by the German government. In the UK, Bradford and Bingley was nationalized by the UK government. If the US banking sector is a good model, then we know that this is just the beginning of bank failures as the dominoes effect triggers more losses. With the ECB interest rate decision scheduled for Thursday, the problems in the banking sector could pressure the European Central Bank to consider easing monetary policy.

On the heels of the bailout plan, the Federal Reserve has injected a tremendous amount liquidity into the global money markets by increasing their swap lines. This is driving gold prices through the roof as inflation fears soar and money flocks out of US dollars and into gold as the safe haven play. Nonetheless, the Fed is trying to tell the market that they are serious about providing liquidity with the size of today’s liquidity injection – they more than doubled their swap limits from $290B to $620B.

US COMPANIES PLAYING DEFENSE COULD BOOST RECESSION RISKS
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